My outlook moving forward into these last 3 months of what has been a very “unique “year!
Q4 update from Banks Financial.
I hope you and yours are happy, safe and healthy!
It was with reluctance that we closed the book on summer. The warm weather allowed us to get out of our COVID-induced cocoons and enjoy the outdoors. The sun was shining, the weather beckoning, and the markets co-operating. As August turned to September, I recall many conversations that went the direction of “I don’t know what we’re going to do this winter,” with the general acceptance that the potential for a second or third wave of COVID infections would reinforce the need for continued physical distancing. My guess? As there was a run on bicycles, swimming pools, and hot tubs this summer, this winter will see a shortage of ski equipment, snowmobiles, and fat bikes. My advice — mainly to myself as
an avid “winter hater”— is to embrace it!
We’ve learned much over the past six months. Global leaders are dealing with COVID outbreaks in new, less economically disruptive ways. We hope and believe this will continue to be the case. The aggregate of economic data may suggest a sluggish recovery. However, I’d argue that the economic data that’s most important to equity markets, the data that has historically correlated strongly with earnings growth, continues to trend in the right direction.
The strength of the current equity market rally has bewildered many investors. The narrative was that this was the worst economic disaster in our lifetime; how could the equity markets not only recover in such a short period of time but also ascend to new heights? First off, no one pretends to have the foresight to have predicted a complete recovery like the one we just had. History would suggest that a full equity recovery wasn’t forthcoming until well into 2021. However, the circumstances around the recession (which we believe is over in Canada and the United States) were vastly different than anything we had seen in our lifetimes. As I mentioned at the start of the pandemic, this is more a disruptive event rather than a destructive event. Therefore, while we’re surprised at how fast the market recovered, we understand why. And it’s for those same reasons we’ve become more confident in equity market returns for the coming 12 months.
Recent unemployment data continues to show a jobs recovery in the United States. The September U.S. Nonfarm Payrolls report showed that slightly more than half of the jobs lost in March and April have been recovered. The unemployment rate has fallen from 14.7% to 7.9% in five months.
The housing data is also a bright spot in this economy. One of our recessionary indicators is the decline of housing starts. Aside from the COVID lockdowns, housing activity has been the strongest in years. This certainly isn’t a sign of an economy in trouble. For the months of June, July, and August, Google search activity for “buying a house” was at its highest in five years. Housing starts have recovered right back to their pre-COVID levels. And housing is key to economic recovery and an equity market recovery.
While not all the economic data is trending in the right direction, some of the data that‘s most important to the equity markets is in the direction we want to see — including retail sales, durable goods orders, and purchasing managers’ indices, to name a few. A great analogy I recently read was:
“We’d compare the evaluation of the current economic conditions to that of a roller coaster ride. A market strategist and an economist exit a roller coaster. The economist is green and holding his stomach; the market strategist is smiling. Whether it was a good ride or not depends on who you ask”!
This is why I believe that passive investing is not for the faint of heart, aka the economist on the roller coaster, and why active management that follows a stringent process and system of stock/bond picking, removes emotion, reduces risk and volatility. A tactical, opportunistic and strategic approach has a history of outperforming benchmark indices with less risk than the benchmark. This is the best way to create consistent risk-adjusted returns, just as we have seen with our portfolio’s performance through “the great pause of 2020”.
Key themes moving forward:
Our base case assumes a gradual economic recovery, despite any COVID relapse over the next 12 months, but perhaps at a different pace market by market.
We expect a full earnings recovery for the S&P 500 Index by Q4 2021/Q1 2022, and similarly for other markets.
Return expectation for the S&P500 over the next 12 months is high single digits.
Global equities (U.S., international, and emerging markets) are favoured over Canada, as oil prices and the correlation to energy weigh on the S&P/TSX Composite Index.
Interest rates will remain low through 2022
Corporate issued bonds will continue to outperform sovereign issued bonds.
We expect the USD to continue to weaken to a basket of currencies, including the Canadian dollar.
The Canadian dollar remains tied to oil and continues its appreciation relative to the USD.
Gold and other commodities that are inversely correlated to the USD will continue to grind higher, contributing to inflation.
In closing, our confidence in a continued economic recovery is greater than it was three or six months ago. That’s not to say there won’t be bumps along the way. Over the next couple of months, we fully expect continued volatility as investors project their political views on the markets. History would show that this is to be expected. In fact, it would be uncharacteristic if we didn’t see volatility leading up to the election.
But with an improving outlook ahead of us, in regards to volatility, as with the pending winter months ahead, I say, “Embrace it!”